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National Debt, are we reacing a tipping point

A couple of items to note: despite interest rates being exceedingly low, and the deficit having dropped to $439B in 2015, the debt grew by $1.4 trillion. 2016 deficit was $535B, yet the debt grew by almost $700B. And 2017 deficit was $666B and the debt grew by almost $700B again. The third column of the first table is key, IMO, because f the debt grows by less than GDP things will not get worse. The debt grows faster than the deficit due to an increasing number of off-budget items.

There is a number, somewhere in the 90% to 120% of debt/gdp ratio to where the debt becomes a permanent drain on economic growth. This was shown convincingly in Reinhart and Rogoff's research described in their book "This Time is Different", despite a well publicized effort by some to discredit all of their research based on an a data error in their spreadsheets.

Now things might really get bad. We have a tax cut and budget that will increase the deficit. The growth republicans counted on may never come due to the existing high debt levels. A much bigger problem than even that is interest rates are going up at the same time the Fed Reserve is attempting to reduce its bond portfolio bought in 2 gigantic rounds of quantitative easing. Simple supply and demand tells you that the bond prices will likely go down just to get people to buy the newly issued treasuries. But when that happens the deficit will just balloon. Even historically normal interest rates of 5% will cost the treasury $400-$500B more a year than the 2% they have been paying.

Something has to be done. And we obviously do not have the political will to address the issue. Praying for 4% economic growth (and it is a prayer) won't work. But the problem is more us, than the politicians, we keep wanting more from our federal government, yet we keep wanting to pay less.

Now, some conservatives have long proposed a balanced budget amendment, but the normal form it is presented has lots of problems. The Hubbard and Kane version is more promising, as it limits federal spending to an average of the last 7 federal reserves, inflation adjusted. This has the obvious effect of allowing typical Keynsian economic policies to work, and it would enforce the reversal of the high spending when times are good. I actually believe it is a good idea, IF we had a functioning congress, we do not, and have not for a decade at least.

I wonder if it could be changed a little, actually kind of reversed. If we had a baseline tax rate on all income levels, and the tax rates (on all levels) was automatically changed each year up or down such that the budget passed by congress any given year the equations for the 7 average year revenue equals the current budget was satisfied. And this could be phased in while immediately keeping the grown in debt below the GDP, or we could even allow a permanent deficit that was say 1/2 of the average GDP growth and have that built into the adjusting tax rate formula.

Congress would then realize their spending would always have a direct impact on taxes and the budget process would be tied to any tax process. In the meantime, we could then safely get rid of the requirement for an authorization of debt ceiling increases.

Ok, I am sure you guys will just turn this into a bash Trump/GOP congress thread. I expect that, but I would like a few objective comments on my idea.

Re: National Debt, are we reacing a tipping point

Originally Posted by peb

John Mauldin's Feb 10th newsletter, "Where We Will Get the Cash" is worth everyone's read:

I disagree with the premise. Private financial assets are currently around $100 trillion. Growing at $10 trillion/year in the long term. Government debt is growing at 10% of that rate. I have just indicated an asset stream we could tax to cover the debt.

The only issue I have with your suggestion is that the numbers might not work out. I guess a second issue I have is that a great deal of income - capital gains, is not counted as it is earned.

Re: National Debt, are we reacing a tipping point

Originally Posted by Too Little Time

I disagree with the premise. Private financial assets are currently around $100 trillion. Growing at $10 trillion/year in the long term. Government debt is growing at 10% of that rate. I have just indicated an asset stream we could tax to cover the debt.

The only issue I have with your suggestion is that the numbers might not work out. I guess a second issue I have is that a great deal of income - capital gains, is not counted as it is earned.

Well in that case you could just sell the whole shebang to private interests. Donald would agree with that.

Re: National Debt, are we reacing a tipping point

Originally Posted by Too Little Time

I disagree with the premise. Private financial assets are currently around $100 trillion. Growing at $10 trillion/year in the long term. Government debt is growing at 10% of that rate. I have just indicated an asset stream we could tax to cover the debt.

The only issue I have with your suggestion is that the numbers might not work out. I guess a second issue I have is that a great deal of income - capital gains, is not counted as it is earned.

It's counted in the UK- the dreaded capital gains tax.
Can't see Trump bringing that one in though!

Re: National Debt, are we reacing a tipping point

So not only would income taxes go up and down, would corporate taxes, excise, should payroll taxes be adjusted to account for social security and Medicare increases?

My idea would be to make all income taxes, corporate and personal, go up and down. I would certainly not make any excise tax or tariff fluctuate. As to payroll taxes, in theory those should not have to fluctuate overtime, as the program's can be adjusted every so often to take into account future shortfalls/surpluses as demographics change (we used to actually do that).

Re: National Debt, are we reacing a tipping point

Originally Posted by Too Little Time

I disagree with the premise. Private financial assets are currently around $100 trillion. Growing at $10 trillion/year in the long term. Government debt is growing at 10% of that rate. I have just indicated an asset stream we could tax to cover the debt.

The only issue I have with your suggestion is that the numbers might not work out. I guess a second issue I have is that a great deal of income - capital gains, is not counted as it is earned.

We do that. The income stream generated off of private assets is taxed, as is the capital gains of those assets. Now, capital gains being a different rate than earned income is a whole different issue, but they are taxed. We could, in theory, tax them the same rate, but we would have to index the cost basis of them based on inflation. Regardless, I do not see where your untaxed "income stream" comes from.

Re: National Debt, are we reacing a tipping point

Originally Posted by peb

We do that. The income stream generated off of private assets is taxed, as is the capital gains of those assets. Now, capital gains being a different rate than earned income is a whole different issue, but they are taxed. We could, in theory, tax them the same rate, but we would have to index the cost basis of them based on inflation. Regardless, I do not see where your untaxed "income stream" comes from.

While you have the theory correct, the practice deviates a great deal.

Re: National Debt, are we reacing a tipping point

Originally Posted by peb

We do that. The income stream generated off of private assets is taxed, as is the capital gains of those assets. Now, capital gains being a different rate than earned income is a whole different issue, but they are taxed. We could, in theory, tax them the same rate, but we would have to index the cost basis of them based on inflation. Regardless, I do not see where your untaxed "income stream" comes from.

I think you could tax capital gains at the same rate as ordinary income without indexing, by using average appreciation of the asset over time to set the rate. Research has shown that there is no economic reason for taxing capital gains at a lower rate, although there is a longstanding myth that there is. I'm convinced that the reason they are taxed at a lower rate is that our senators and their donors make a lot of their income from capital gains.

The real trick with the national debt is to actually pay it down when times are good. That's what's so egregious about cutting taxes and increasing spending right now. You certainly don't want to increase taxes during a recession, that would just make recessions worse, and that's the main problem with a balanced budget amendment.

Re: National Debt, are we reacing a tipping point

Originally Posted by johnw

I think you could tax capital gains at the same rate as ordinary income without indexing, by using average appreciation of the asset over time to set the rate. Research has shown that there is no economic reason for taxing capital gains at a lower rate, although there is a longstanding myth that there is. I'm convinced that the reason they are taxed at a lower rate is that our senators and their donors make a lot of their income from capital gains.

The real trick with the national debt is to actually pay it down when times are good. That's what's so egregious about cutting taxes and increasing spending right now. You certainly don't want to increase taxes during a recession, that would just make recessions worse, and that's the main problem with a balanced budget amendment.

Not for sure what you mean by "by using average appreciation of the asset over time to set the rate". Lets just take a simple example. Suppose I invest $100K in a business and then sell it two years later for $105K. Let us assume inflation was 2.5% each of the two years. With no indexing, I would pay taxes on a $5000 gain, even thought there was no real (ie non inflation) gain. Now, that's that way it works now, but if we instead assume that I had a 5% yearly gain, I pay capital gains rate on $10K (approximately), which works out to paying the rate on $5K yearly gain, which works out to be taxed very close to normal income.

How does your "using average appreciation of the asset over time to set the rate" keep me from paying taxes when I had no real gain in the first example, or paying normal income rates on twice the real gain in the second example?

Please answer, but lets not get too sidetracked. We can debate capital gain rates, or any other marginal rate all day long, I am more interested in your opinion of my overall concept. I know its just an intellectual exercise, since no politican is proposing it, but we all do that sometimes.

Re: National Debt, are we reacing a tipping point

Originally Posted by peb

Not for sure what you mean by "by using average appreciation of the asset over time to set the rate". Lets just take a simple example. Suppose I invest $100K in a business and then sell it two years later for $105K. Let us assume inflation was 2.5% each of the two years. With no indexing, I would pay taxes on a $5000 gain, even thought there was no real (ie non inflation) gain. Now, that's that way it works now, but if we instead assume that I had a 5% yearly gain, I pay capital gains rate on $10K (approximately), which works out to paying the rate on $5K yearly gain, which works out to be taxed very close to normal income.

How does your "using average appreciation of the asset over time to set the rate" keep me from paying taxes when I had no real gain in the first example, or paying normal income rates on twice the real gain in the second example?

Please answer, but lets not get too sidetracked. We can debate capital gain rates, or any other marginal rate all day long, I am more interested in your opinion of my overall concept. I know its just an intellectual exercise, since no politican is proposing it, but we all do that sometimes.

Your point is well taken, and inflation indexing would probably work best.

I'm much more concerned with the fact that most efforts to control the debt seem to eliminate the natural stabilizers that keep recessions from being deeper, and foreclose using fiscal policy to combat recessions.

"We had this puzzle that we were unable to replicate the results that Reinhart-Rogoff published," Prof Ash, says. "And that really got under our skin. That was really a mystery for us."

So Ash and his colleague Prof Robert Pollin encouraged Herndon to continue the project and to write to the Harvard professors. After some correspondence, Reinhart and Rogoff provided Thomas with the actual working spreadsheet they'd used to obtain their results.
"Everyone says seeing is believing, but I almost didn't believe my eyes," he says.
Thomas called his girlfriend over to check his eyes weren't deceiving him.

But no, he was correct - he'd spotted a basic error in the spreadsheet. The Harvard professors had accidentally only included 15 of the 20 countries under analysis in their key calculation (of average GDP growth in countries with high public debt).
Australia, Austria, Belgium, Canada and Denmark were missing.

Thomas and his supervisors also didn't like the way that Reinhart and Rogoff averaged their data. They say one bad year for a small country like New Zealand, was blown out of proportion because it was given the same weight as, for example, the UK's nearly 20 years with high public debt.

"I think that's a mistaken way to examine these data.""New Zealand's single year, 1951, at -8% growth is held up with the same weight as Britain's nearly 20 years in the high public debt category at 2.5% growth," Michael Ash says.

Reinhart and Rogoff based their paper on a mistake. The paper was influential because it said something a lot of people preferred to believe, but by 2013 it became evident that they had based what seemed like a solid conclusion on an error. This came to light because other economists could not replicate their results from the data. Reinhart and Rogoff have admitted the spreadsheet error, but say their central claim was true, even though the data now seems to show that there is no clear tipping point. High debt can hurt economic performance, but there's no sudden tipping point, the effect is gentler than the original study claimed, and there are cases where this doesn't seem to happen at all.

So, yes, we need to control the debt, but we need to be sensible about how we do it, reducing debt when times are good and increasing it when times are bad. Seven fat cows, seven thin cows, this stuff has been known since Biblical times.

Re: National Debt, are we reacing a tipping point

johnw, I acknoiwledge the fault in the original Reinhart and Rogoff paper, but that fault was never to the point of debunking their findings. They released their paper in 2010, at a time when the stimulus vs austerity debate was raging throughout the world. Since their findings were used by politicians to support the austerity argument, they were heavily criticized and their error was exaggerated in importance. Their findings are not all wrong and I am not basing my conclusions on a debunked theory. Their response to the error is given here :

Please note this paragraph:
"A sober reassessment of austerity is the responsible course for policy makers, but not for the reasons these authors suggest. Their conclusions are less dramatic than they would have you believe. Our 2010 paper found that, over the long term, growth is about 1 percentage point lower when debt is 90 percent or more of gross domestic product. The University of Massachusetts researchers do not overturn this fundamental finding, which several researchers have elaborated upon."

More importantly:

Originally Posted by johnw

So, yes, we need to control the debt, but we need to be sensible about how we do it, reducing debt when times are good and increasing it when times are bad. Seven fat cows, seven thin cows, this stuff has been known since Biblical times.

I agree with this, I am a Keynesian at heart. That is exactly why both my idea and the source of my idea, referenced my first post, used a 7 year average for the mechanism. The intent is to allow for increasing deficit/debt when times are bad and decreasing it when times are good.

Re: National Debt, are we reacing a tipping point

Originally Posted by peb

johnw, I acknoiwledge the fault in the original Reinhart and Rogoff paper, but that fault was never to the point of debunking their findings. They released their paper in 2010, at a time when the stimulus vs austerity debate was raging throughout the world. Since their findings were used by politicians to support the austerity argument, they were heavily criticized and their error was exaggerated in importance. Their findings are not all wrong and I am not basing my conclusions on a debunked theory. Their response to the error is given here :

Please note this paragraph:
"A sober reassessment of austerity is the responsible course for policy makers, but not for the reasons these authors suggest. Their conclusions are less dramatic than they would have you believe. Our 2010 paper found that, over the long term, growth is about 1 percentage point lower when debt is 90 percent or more of gross domestic product. The University of Massachusetts researchers do not overturn this fundamental finding, which several researchers have elaborated upon."

More importantly:

I agree with this, I am a Keynesian at heart. That is exactly why both my idea and the source of my idea, referenced my first post, used a 7 year average for the mechanism. The intent is to allow for increasing deficit/debt when times are bad and decreasing it when times are good.

Now your bias is showing. The error was important because it debunked the tipping point thesis, which liberals such as President Obama had accepted early on. The tipping point idea has also found its way into the title of this thread. If there is no such tipping point, but a gentle slope to this effect, there are policy implications. That high levels of debt can hamper economic growth has been known at least as far back as Hamilton, who said: "A national debt, if it is not excessive, will be to us a national blessing."

In the end, Rogoff and Reinhart went from claiming a revolutionary result to simply having proved conventional wisdom. I don't think we need new controls, just wiser policy makers. If Bill Clinton could start paying down the debt, how hard can it be? Of course, at the time, Republicans gave him his tax increase because they still believed their own propaganda about how the higher taxes would destroy the economy, and they wanted him to own the result.

Since then, Republicans have followed a program of claiming the debt needs to be paid down when Democrats are in office, then increasing the debt when Republicans are in office. This is not an economic policy, it's a spoils system. I suspect such cynicism is part of why you are no longer a Republican.

I am not convinced that a seven year average solves the problem. Would that have been enough for the Long Depression or the Great Depression? It seems to me that the depth of the depression, not the spending level before the depression, would dictate what fiscal policy might be needed. For example, Australia was running a higher level of inflation before the 2008 crisis hit, which put them further from the zero lower bound and made their monetary policy more effective than it was in countries with lower inflation. They didn't need as much of a boost from fiscal policy, so why mandate it? If the problem is more complicated than fiscal policy, Hubbard and Kane's idea could do more harm than good.

What we really need is for voters to reject the dishonest policy that claims tax cuts biased toward the wealthy are always the right thing to do.

Take a look at national debt as a percentage of GDP:

National debt didn't start to explode until the Reagan administration, and in fact from the late 1940s through the 1960s it was shrinking in proportion to the size of the economy. It started to shrink in proportion to the economy again during the Clinton administration, then exploded again during the last recession.

What that shows me is that we don't need gimmicks. We need good government, and the means to achieve that are no further than the nearest election.

Financial assets were valued at about $40 trillion in 2014. The stock market was up over 10% that year. So $4 trillion in capital gains. If capital gains had not been deferred, tax revenue would have been increased by $500 billion. If capital gains had been taxed at wage rates rather than capital gains rates, revenue would have been increased by another $500 billion.

Currently taxable gains are concentrated at the top end of the income scale. 70% go to the top 1%. another 20% go to the next 9%. Currently financial assets are over $80 trillion. At typical market returns I would expect current revenue from capital gains to be twice what I stated above.

The Tax Policy gives at least one method to encourage recognition of capital gains with the expected increase in tax revenue. One could tailor a tax policy to achieve whatever goal one wants and still raise a lot of revenue.